Offshoring pays off but not as much as you think

By Alan R. Earls

01/01/2005

Santa Clara, California-based Everypath claims to have found happiness running its own offshore operations. Everypath is a company that targets customized versions of its customer service software to global 1000 companies, and, like hundreds of other American-based firms, it has seen the boom and bust times and is under constant pressure to control costs in a demanding economic environment.

Almost from its inception in 1998, though, Everypath launched its own captive offshore development facility in India.

According to CEO Mark Tapling, that operation reached a peak of 40 employees before the dot-com bubble burst, forcing the company to pull back temporarily while it reviewed its strategy. After a brief hiatus, the company rebuilt its Indian presence with a smaller, refocused team that today represents about half the company’s development talent and a crucial edge over its competition.

Tapling admits that outsourcing to countries such as India has lost its luster, and some of its advantages are diminishing. Demand has raised wages, and turnover in overheated hiring markets is often in the double digits as companies and individuals position themselves to make the most of their new opportunities.

Other offshore markets are going through the same process, although at a slower rate. Meanwhile, American wages have, in general, slipped from the peaks they reached in the dot-com era. The net result is that the wage differential between onshore and offshore is not as great as it once was.

Silver bullets can hurt
However, the picture is more complicated than that. Process efficiency, management challenges, the nature of the projects and other factors have a lot to do with the success of offshoring and whether it provides financial benefits. Conversely, offshore providers and the infrastructure that support them are maturing, making offshoring less complex and risky than it was even a few years ago.

“Offshoring is going through the same process that all the IT silver bullets go through,” says Denny Morris, service manager at Parsippany, N.J.-based Delta Corporate Services, an IT consultant to the federal government. “There are some good reasons to do it, and the trend toward more commoditized technology is driving some of that,” he says.

However, because management and governance are really the crux of IT success, “If offshoring is the only silver bullet in your gun, chances are you’ll shoot yourself with it,” he adds.

Going beyond wages
Many industry followers warn against expecting an order of magnitude or greater cost savings, which a glance at comparative wage rates sometimes implies. For instance, Robbie Nakatsu, a professor at Loyola Marymount University in Los Angeles, reckons offshoring will only yield 15 to 30 percent net savings. Joseph Feiman, vice president of research at Gartner, offers an assessment that is only slightly more generous—25 to 40 percent.

It boils down to the cost of doing business that Nakatsu says includes the
impact on the morale of onshore employees, severance costs for terminated employees and increased travel expenses required to manage offshore work.

Gartner has made an effort to quantify and measure as many of these external factors. Feiman explains his team has tried to focus on three areas that go beyond a simple comparison of wage rates. The first is effort allocation, the second is communication—a euphemism for “cultural and geographic distance,” he explains, and the third is the “effectiveness of your organization and that of the external provider.”

In the communication area, for instance, Feiman says Gartner tries to assess vendor writing and speaking abilities and the potential disruption wrought by time zones on process flow. “Think about what it means to productivity if you have to wait eight hours to get an answer to a simple question,” he says.

Feiman also looks at areas such as the challenges of building trust between teams, the stability of organizations and nations (a risk factor in places like Russia, the Ukraine, and even India) and the quality of the work.

Feiman says the different phases of IT projects—analysis, design and construction, unit testing, system testing, and deployment—are susceptible to outsourcing or offshoring in different degrees. Analysis, for example, requires extensive work with business experts and, therefore, is best done on site. “At least 60 percent of design should probably be done on site and, if you are really good, maybe 40 percent can be done offsite,” he says.

Similarly, deployment and system testing require onsite presence. What can be moved offsite with relative ease is only construction and unit testing, he says. “That means, realistically, you are only going to get the benefits of offshoring for a portion of your project, perhaps a fairly small portion,” he adds.

Enthusiastic about quality
By most accounts, offshore IT suppliers in India have been wholehearted adopters of the Capability Maturity Model, developed at Carnegie Mellon University, and many are certified to CMM level 4 or 5. Vendors in other nations seem to be following the Indian lead. Indeed, notes one observer, the enthusiasm shown overseas for CMM is not unlike the manufacturing quality revolution begun decades ago by companies like Toyota, using American methodologies.

Still, CMM alone doesn’t guarantee results. Frank Mazzucco, a senior consultant at Compass America in Dallas, who specializes in process maturity disciplines such as CMM and ISO, recently spent time in India on behalf of his clients, reviewing the capabilities of a number of top Indian developers. Although the primary benefit of the offshore model is potential cost savings, he says, customers find it difficult to track other performance measures, such as productivity and quality. In other words, offshore developers may cost less, but there’s no way of knowing if offshore projects take as long, twice as long, or four times as long as traditional projects.

He says one potential pitfall comes when client organizations seek to buy process discipline from Indian vendors without making a corresponding investment in their internal capabilities. Process discipline creates work for the client, in terms of documentation, specification, and review. If the client doesn’t have organization to assimilate these sophisticated processes, the vendor will end up ratcheting down its capabilities. An offshore developer can provide a significant process improvement but won’t be able to take an organization any further than it’s ready to go, he says.

Mazzucco says the bottom line is that the only way to effectively manage any type of development project—whether onshore or offshore—is to focus on the basics of scope, schedule, budget, and quality, and to introduce a methodology of discipline, measurement, and repeatability. That methodology should include a means for continually tracking vendor performance based on development of performance targets, comparison points to industry norms, and a clear schedule, he notes.

Of course, offshoring can put intellectual property and intellectual capital at risk. Will key code or business process knowledge (potentially just as valuable) get lost or misappropriated? Also, there’s the potential that cutting onshore capabilities in favor of potentially less-expensive offshore resources could hobble future development efforts or even affect maintainability. To their credit, offshore vendors often make extraordinary efforts to address security concerns.

Nakatsu says an organization must view and address all these issues strategically, rather than plunge into an offshore arrangement just to save a few dollars in the short term.

Captive operations
Setting up a captive operation offshore is one way to reduce, or perhaps eliminate, the risk that valuable intellectual property will be stolen.

Everypath’s Tapling says it was once true that only very large companies could afford to set up captive operations. Now, he says, decreasing costs and improvements in infrastructure mean that even operations employing small teams can be viable. “I’m not talking about two or three people, but perhaps a bit bigger than that,” he says. What is key is making sure your onshore organization knows how it will use the offshore group and then hires appropriately. “It doesn’t make any sense to set up an operation for just one project—it should be part of your ongoing process like an onshore asset,” he explains.

What could go wrong
According to Tapling, programmers in India are usually very well trained but often lack specific domain expertise. “Someone who grew up in a rural area of India and graduated from a good school still doesn’t really have a sense of what things need to look like for an equity trader in midtown Manhattan,” he says.

Bart Higgins, executive vice president for sales and marketing at Auriga, in Amherst, N.H. spent several years working for an Indian outsourcer and recently moved to Auriga, a software development firm that focuses on outsourcing to Russia.

Higgins says the main point is not whether the vendor is offshore or local. “Once you go to an external provider you must always factor in extra costs for management, and you must change the structure and process you use, too,” Higgins says.

Higgins says managers are often used to managing by input-based methods. So, for example, they watch programmer X or programmer Y to see if he or she is at work on time. However, Higgins cautions, those methods don’t work for offshoring, or for most kinds of outsourcing. Instead, managers need to find, and regularly evaluate, output-based indicators like bits of code, for example. And they must communicate regularly and effectively to make sure they know where each part of a project is in its development and whether elements are getting off track. “You must be ready to flag issues earlier and be more proactive in resolving them,” he says.

For his part, Everypath’s Tapling says his message to the software community is that offshoring works. “There are additional costs involved in management and maintaining communications, but there are definitely benefits, too,” he says. “Don’t shy away from it, you’ve got to do it,” he urges.

Discussion Points

THE PERILS OF OFFSHORING

• Increased demand for offshoring has raised wages and increased turnover in
hot job markets, taking some of the luster off the global outsourcing picture.
• Although many Indian providers are at level 4 or 5 of the Capability
Maturity Model, that can backfire when a customer firm’s software development
processes are not as mature, and can create extra work for the client. •
Many industry experts warn against expecting a windfall in cost savings. One
sees only a 15 to 30 percent savings, while another sees 25 to 40 percent. •
Don’t neglect the costs (such as severance pay) involved in terminating onshore
employees whose jobs are being offshored, and the morale of those who will
remain on the payroll.